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Chapter 1

Discussion Questions
1-1.

The first area to generate enthusiasm was capital budgeting in which the financial manager
was presented with analytical techniques for allocating resources among the various assets
of the firm.

1-2.

The student should be prepared to pay a higher price for the promised $2 from the Royal
Bank. The risk is lower.

1-3.

The goal of shareholder wealth maximization implies that the firm will attempt to achieve
the highest possible valuation in the marketplace. It is the one overriding objective of the
firm and should influence every decision. The problem with a profit maximization goal is
that it fails to take account of risk, the timing of the benefits is not considered, and profit
measurement is a very inexact process.

1-4.

Agency theory examines the relationship between the owners of the firm and the managers
of the firm. In privately owned firms, management and the owners are usually the same
people. Management operates the firm to satisfy its own goals, needs, financial
requirements and the like. As a company moves from private to public ownership,
management now represents all owners. This places management in the agency position of
making decisions in the best interest of all shareholders.

1-5.

Because institutional investors such as pension funds (Ontario Teachers’, CPP) and mutual
funds own a large percentage of major companies, they are having more to say about the
way publicly owned companies are managed. As a group, they have the ability to vote
large blocks of shares for the election of a board of directors, which is suppose to run the
company in an efficient, competitive manner. The threat of being able to replace poor
performing boards of directors makes institutional investors quite influential. Since these
institutions, like pension funds and mutual funds, represent individual workers and
investors, they have a responsibility to see that the firm is managed in an efficient and
ethical way.

1-6.

Insider trading occurs when someone has information that is not available to the public
and then uses the information to profit from trading in a company’s common stock. The
provincial securities commissions are responsible for protecting against insider trading.

1-7.

Regulations set the “rules of the game” in which the firm operates. Shareholder wealth
maximization can and should still be sought within the rules for economic efficiency to be
achieved. With deregulation occurring today, society is judging the benefits against the
costs of regulation.

Foundations of Fin. Mgt.

S-1

6/E Cdn. • Block, Hirt, Short

with limited partners obligated only to the extent of their initial contribution.1-8. Occasional. Also. only the general partner(s) has unlimited liability. • Block. Short . Capital markets refer to securities with a life of more than one year. www. 1-13. all shareholders in a corporation have limited liability.pdf www. A liquid secondary market promotes a successful primary market. 1-11.gc. If managers do not act to maximize shareholder wealth. share prices will become depressed. S-2 6/E Cdn. they trade in the secondary market between investors. Management operates within a competitive market and they should be paid their opportunity cost. Daily functions. receipt and disbursement of funds. and there exists a market for corporate control. shareholders can fire managers. inventory control.ca/en Foundations of Fin. 1-14. 1-9.share issue. The corporate form is best suited to large organizations because of the easy divisibility of ownership through issuance of shares. A primary market refers to the use of the financial markets to raise new funds. Finally. After the securities are sold to the public (institutions and individuals). It is in the secondary market that prices are continually changing as investors buy and sell securities based on the expectations of corporate prospects. 2. bond issue. Internet Resources and Questions 1. There is unlimited liability for the sole proprietorship and partnership forms of ownership.ca/afr/2001/frt01_e. management will be compensated based on their economic contribution. 1-12. although owner/ shareholders of small businesses often have to give banks their personal guarantees. putting upward pressure on interest rates and a corporation’s ability to invest in capital projects. Under the limited partnership. but there have been less ‘risk free’ government securities available (causing liquidity problems particularly in the money markets). When governments finance their deficits abroad they place Canada’s economic levers outside of our control and debt servicing payments can impact the foreign exchange markets. the corporation has continued existence independent of any shareholder. To the extent manager’s compensation is tied to share price performance. capital budgeting and dividend decisions. This puts large demands (over $800 billion in accumulated federal and provincial debt in 1996) on the capital markets. Money markets refer to those markets dealing with short-term securities that have a life of one year or less.nobel. Government debt loads require financing.bankofcanada. corporations have borrowed more. As government debt loads have been reduced in recent years there has been less pressure on interest rates. Mgt. 1-10. Hirt.se www.fin. 3.cash management.